Chapter 26 Corporate Liquidation and Reorganization

Multiple Choice Theory

1. D
6. D
11.
2. D
7. E
12.
3. A
8. B
13.
4. D
9. A
14.
5. D
10. C
15.

B
C
A
D
C

16.
17.
18.
19.
20.

D
B
D
A
D

A
B
A
C
C

21.
22.
23.
24.
25.

21.
22.
23.
24.
25

A
C
A
C
B

26.
27.
28.
29.
30.

C
B
C
D
C

Multiple Choice Computational

Answers at a glance:
1. C
6. B
11.
2. A
7. A
12.
3. B
8. D
13.
4. D
9. B
14.
5. A 10. C
15.

D
B
A
C
D

16.
17.
18.
19.
20.

B
A
B
B
C

26.
27.
28.
29.
30.

D
C
B
B
A

31.
32.
33.
34.
35.
36.

D
C
A
A
D
A

Solutions:
1. C Land and building at net selling price of 10,400,000
2. A Equipment at net selling price of 800,000
3. B
Solution:
Assets pledged to fully
secured creditors:
Land and building
Less: Loan payable
Interest payable

Realizable
value
10,400,000
(8,000,000)
(60,000)

Assets pledged to partially secured

creditors:
Equipment, net
800,000
Free assets:
Cash
Accounts receivable
Note receivable
Interest receivable
Inventory
Prepaid assets
Total free assets

160,000
668,800
400,000
40,000
1,640,000
-

228

Available for
unsecured creditors

2,340,000

2,908,800
5,248,800

4. D
Solution:
Unsecured liabilities with
priority:
Estimated admin. expenses

Accrued salaries
Current tax payable
Total unsecured
liabilities with priority
Fully secured creditors:
Loan payable
Interest payable
Partially secured creditors:
Note payable
Less: Equipment

Secured and
Priority claims
120,000
100,000
1,400,000

Unsecured liabilities
without priority

1,620,000

8,000,000
60,000
8,060,000

1,200,000
(800,000)

400,000

Unsecured liabilities without priority:

Accrued expenses, net of
accrued salaries
(884K 100K)

Accounts payable
Total unsecured
liabilities without priority

784,000
4,000,000

4,784,000
5,184,000

Total free assets

Less: Total unsecured liabilities with priority
Net free assets

5,248,800
(1,620,000)
3,628,800

5. A (See solution above)

6. B (See solution above)
7. A (See solution above)
8. D (See solution above)
9. B
Solution:
Total unsecured liabilities w/o priority (see above)
Multiply by: (100% - 70%* recovery)
Deficiency

5,184,000
30%
1,555,200

229

* See computation below.

10. C
Solution:
Estimated recovery percentage
of unsecured creditors without
priority

Net free assets

Total unsecured liabilities
without priority

Total free assets

Less: Total unsecured liabilities with priority
Net free assets
Divide by: Total unsecured liabilities without priority
Estimated recovery percentage of unsecured
creditors without priority

5,248,800
(1,620,000)
3,628,800
5,184,000
70%

11. D
12. B
Solution:
Jan.
Cash
1,
Accounts receivable
20x1
Note receivable
Inventory
Prepaid assets
Land
Building
Equipment
Estate deficit (squeeze)
Accrued expenses
Current tax payable
Accounts payable
Note payable
Loan payable

160,000
880,000
400,000
2,120,000
40,000
2,000,000
8,000,000
1,200,000
684,000
884,000
1,400,000
4,000,000
1,200,000
8,000,000

13. A
Solution:
Assets to be realized is 14,640,000, equal to the total book value
of the assets, excluding cash, transferred to the receiver
(14,840,000 total assets less 160,000 cash).
14. C
Solution:
Assets acquired is 40,000, representing the previously unrecorded
interest receivable.
230

15. D
Solution:
Assets realized is equal to the actual net proceeds from the sale of
assets, as summarized below:
660,000
a. Collection of accounts receivable
400,000
b. Collection of note and interest receivables
1,180,000
c. Sale of half of the inventory
10,400,000
e. Sale of land and building
880,000
f. Sale of equipment
13,520,000
Assets realized
16. A
Solution:
Assets not realized is equal to the book value of the unsold
inventory of 1,060,000 (2,120,000 x 50%).
17. B
Solution:
Liabilities to be liquidated is 15,484,000, equal to the total book
value of the liabilities transferred by ABC Co. to the receiver.
18. A
Solution:
Liabilities assumed is 60,000, representing the previously
unrecorded interest payable.
19. C
Solution:
Liabilities liquidated is equal to the actual settlement amounts of
the liabilities settled, as summarized below:
100,000
g. Payment for accrued salaries
1,400,000
h. Payment for current tax payable
8,060,000
i. Payment for interest and loan payables
880,000
j. Payment for note payable
10,440,000
Liabilities liquidated
20. C
Solution:
Liabilities to be liquidated is equal to the total book value of the
unsettled liabilities summarized below:
784,000
Accrued expenses, net of accrued salaries
4,000,000
Accounts payable
4,784,000
Liabilities to be liquidated
231

21. B
Solution:
Debits
Assets to be realized,
excluding cash
Assets acquired

Credits

14,640,000 13,520,000
40,000

1,060,000

Liabilities liquidated

10,440,000 15,484,000

Liabilities not liquidated

4,784,000

Supplementary expenses
Totals
Net gain - excess credits
over debits

Assets realized

60,000

Assets not realized

Liabilities to be
liquidated
Liabilities assumed

Supplementary
income
30,012,000 30,124,000 Totals
108,000

112,000

*Supplementary expense is equal 108,000, representing the

administrative expenses paid during the period.
22. A
Solution:
Claim

Government - unsecured
liability with priority
XYZ Bank - fully secured
creditor
Alpha Financing Co. partially secured creditor
Mr. Bombay - unsecured
liability without priority

400,000
4,200,000
3,200,000
1,200,000

Recovery
percentage
100%
100%
2M + (1.2M x
40%*)

40%*

Estimated
recovery
400,000
4,200,000
2,480,000
480,000

*(40% = 288,000 720,000)

23. B (See solution above)
24. B
Solution:
Total assets at realizable values
Less: Unsecured creditors with priority
Fully secured creditors
Realizable value of assets pledged to partially
secured creditors
Net free assets

232

1,248,000
(288,000)
(384,000)
(192,000)
384,000

25. C
Solution:
Estimated recovery percentage
of unsecured creditors without
priority

Net free assets

Total unsecured liabilities
without priority

Unsecured creditors without priority

Deficiency of assets pledged to partially secured creditors
(240K 192K)

Total unsecured liabilities without priority

432,000
48,000
480,000

Estimated recovery percentage =

384,000 (see previous computation) 480,000 = 80%
26. D
Solution:
Net free assets
Less: Total unsecured liabilities without priority
Estimated deficiency to unsecured creditors without
priority

384,000
(480,000)
(96,000)

27. C
Solution:
Unsecured liability with priority
Fully secured creditor

288,000
384,000

Recovery
percentage
100%
100%

Partially secured creditor

Unsecured liability without priority

240,000

48K +
(48K x 58%)

230,400

432,000

80%

345,600

Claim

Total

Estimated
recovery
288,000
384,000

1,248,000

28. B (See solution above)

29. B
Solution:
Since only the results of the liquidation process are provided in the
problem, we need to reconstruct the information on assets and
liabilities using the provided information on equity. This information
can be determined using the basic accounting equation.
Assets less Liabilities (at book value) = Capital (at book value)
= 1,600,000 (2.8M 1.2M)
1,600,000 (squeeze)
The recovery percentage of shareholders is computed as follows:
Assets less Liabilities at book value
1,600,000
233

Gains on realization of assets

Losses on realization of assets
Additional assets discovered and realized during
liquidation
Additional liabilities recorded and settled during
liquidation
Net assets available to shareholders
Divide by: Book value of shareholders' equity
Recovery percentage of shareholders

720,000
(1,280,000)
200,000
(120,000)
1,120,000
1,600,000
0.70

30. A Answer: 800,000 (1M x 20% recovery of inside creditors)

31. D None Before anything can be paid to owners, all of the
claims of creditors, outside and inside, must be paid first. Since
inside creditors are not paid in full, none will be paid to owners.
32. C
Solution:
The net free assets are computed as follows:
Amount realized from sale of assets
Amount paid out of the proceeds (540K + 370K)
Realizable value of remaining assets (320K+140K+515K)
Total assets at realizable values
Less: Unsecured creditors with priority (260K + 40K
estimated liquidation expenses)

Fully secured creditors (limited to realizable value of

collateral) - (error) a
Realizable value of asset pledged to partially secured
creditors
Net free assets

3,760,000
(3,640,000)
3,900,000
4,020,000
(1,200,000)
(1,280,000)
(560,000)
980,000

The total unsecured liabilities without priority are computed as follows:

1,960,000
Unsecured creditors without priority (1.76M+200K)
Deficiency of assets pledged to "fully" secured creditors
160,000
(error) a
Deficiency of assets pledged to to partially secured
40,000
creditors [(2.080M 1.48M) - 560K]
2,160,000
Total unsecured liabilities without priority
a

The assets described in the accountants working papers as

pledged to fully secured creditors are actually pledged to
partially secured creditors (also, the fully secured creditors are
actually partially secured) as shown in the computations below:
234

1,440,000
1,280,000
160,000

Unpaid balance of fully secured liabilities (3.6M 2.16M)

Assets pledged to fully secured creditors

Deficiency to "fully" secured creditors
Estimated recovery percentage
of unsecured creditors without
priority

Net free assets

Total unsecured liabilities
without priority

= (980,000 2,160,000) = 45.37%

33. A
Solution:
Date
Various assets (at book value)
Estate deficit (squeeze)
Various liabilities (at book value)

1,200,000
80,000
1,280,000

34. A
Solution:
Total assets at realizable value (1M + 20K dividend

1,020,000

receivable)

Total liabilities at realizable value (1.28M + 8K interest

(1,328,000)

payable + 40K estimated administrative expenses)

Estimated deficiency to unsecured creditors without

priority

(308,000)

35. D
Solution:
Debits

Credits

Assets to be realized
Assets acquired

8,000,000
60,000

4,720,000
880,000

Liabilities liquidated

8,520,000

11,480,000

Liabilities not liquidated

4,760,000

128,000

100,000

72,000

21,440,000

17,280,000

Supplementary expenses
Totals

4,160,000

235

Assets realized
Assets not realized
Liabilities to be
liquidated
Liabilities assumed
Supplementary
income
Totals
Net Loss excess
of debits over
credits

36. A
Solution:
ASSETS
Cash
Assets not
realized
TOTALS

400,000

(Squeeze)

880,000

LIABILITIES AND EQUITY

Liabilities not
liquidated
4,760,000
Estate deficit

1,280,000

(Start)

(3,480,000)

TOTALS

1,280,000

Exercises
1. Solution:
Book values
5,000,000

600,000
80,000
440,000
200,000
1,060,000
20,000

Realizable
values

ASSETS

Assets pledged to fully secured creditors:

Land and building
5,200,000
Loan payable
(4,000,000)
Interest payable
(30,000)

Free assets:
Cash
Accounts receivable
Note receivable
Interest receivable
Inventory
Prepaid assets
Total free assets
Less: Unsecured liabilities
with priority (see below)
Net free assets
Estimated deficiency (squeeze)

80,000
334,400
200,000
20,000
820,000
-

(1,296,000 - 907,200)

50,000
700,000

1,170,000

Assets pledged to partially secured creditors:

Equipment, net
400,000

7,400,000

Book values

Available for
unsecured
creditors

LIABILITIES AND EQUITY

Realizable
values

Unsecured liabilities with priority:

Administrative expenses
60,000
Accrued salaries
50,000
Current tax payable
700,000
Total unsecured liabilities
810,000
with priority
Fully secured creditors:

236

1,454,400
2,624,400
(810,000)
1,814,400
388,800
2,592,000
Unsecured
non-priority
liabilities

4,000,000

600,000

392,000
2,000,000
(342,000)
7,400,000

Loan payable
Interest payable

4,000,000
30,000

Partially secured creditors:

Note payable
Equipment, net

600,000
(400,000)

Unsecured creditors
Accrued expenses, net of
accrued salaries
Accounts payable
Total unsecured creditors
Shareholders' equity

2. Solutions:
Requirement (a):
Jan.
Cash
1,
Accounts receivable
20x1
Note receivable
Inventory
Prepaid assets
Land
Building
Equipment
Estate deficit (squeeze)
Accrued expenses
Current tax payable
Accounts payable
Note payable
Loan payable

200,000

392,000
2,000,000

2,392,000
2,592,000

2,592,000

80,000
440,000
200,000
2,120,000
20,000
1,000,000
4,000,000
600,000
342,000
442,000
700,000
2,000,000
600,000
4,000,000

Requirement (b):
ASSETS
Assets to be realized:
Assets realized:
Accounts receivable
440,000 Accounts receivable
Note receivable
200,000 Note receivable
Inventory
1,060,000 Interest receivable
Prepaid assets
20,000 Inventory
Land and building
5,000,000 Land and building
Equipment, net
600,000 Equipment
7,320,000 Total
Total

237

330,000
180,000
20,000
590,000
5,200,000
440,000
6,760,000

Assets acquired:

Assets not realized:

Interest receivable

20,000

Liabilities liquidated:
Accrued expenses
Current tax payable
Interest payable
Loan payable
Note payable
Total

Inventory

530,000

LIABILITIES
Liabilities to be liquidated:
50,000 Accrued expenses
442,000
700,000 Current tax payable
700,000
30,000 Accounts payable
2,000,000
4,000,000 Note payable
600,000
440,000 Loan payable
4,000,000
5,220,000 Total
7,742,000

Liabilities not liquidated:

392,000
Accrued expenses
2,000,000
Accounts payable
2,392,000
Total

Liabilities assumed:
Interest payable

30,000

SUPPLEMENTARY ITEMS
Supplementary expenses:
Supplementary income:
Administrative
54,000
expenses
Net gain during the
56,000
period
15,062,000

15,062,000

Requirement (c):
Beg. bal.
Assets realized

Cash
80,000
6,760,000 5,220,000
54,000
1,566,000

Liabilities liquidated
Administrative expenses

3. Solution:
Claim

Government - unsecured
liability with priority
XYZ Bank - fully secured
creditor
Alpha Financing Co. partially secured creditor
Mr. Bombay - unsecured
liability without priority

200,000

Recovery
percentage

Estimated
recovery

100%

200,000

2,100,000

100%

2,100,000

1,600,000

500K + (300K
x 40%*)

1,240,000

600,000

238

40%*

240,000

*(40% = 144,000 360,000)

4. Solution:
Requirement (a):
Total assets at realizable values
Less: Unsecured creditors with priority
Fully secured creditors
Realizable value of assets pledged to partially
secured creditors
Net free assets
Requirement (b):
Estimated recovery percentage
of unsecured creditors without
priority

624,000
(144,000)
(192,000)
(96,000)
192,000

Net free assets

Total unsecured liabilities
without priority

Unsecured creditors without priority

Deficiency of assets pledged to partially secured creditors
(60K 48K)

Total unsecured liabilities without priority

108,000
12,000
120,000

Estimated recovery percentage =

96,000 (see previous computation) 120,000 = 80%
Requirement (c):
Net free assets
Less: Total unsecured liabilities without priority
Estimated deficiency to unsecured creditors without
priority

192,000
(240,000)
(48,000)

Requirement (d):
Unsecured liability with priority
Fully secured creditor

144,000
192,000

Recovery
percentage
100%
100%

Partially secured creditor

Unsecured liability without priority

120,000

48K +
(24K x 58%)

115,200

216,000

80%

172,800

Claim

Estimated
recovery
144,000
192,000

624,000

Total

5. Solution:
Since only the results of the liquidation process are provided in the
problem, we need to reconstruct the information on assets and
239

liabilities using the provided information on equity. This information

can be determined using the basic accounting equation.
Assets less Liabilities (at book value) = Capital (at book value)
=
800,000 (squeeze)
800,000 (1.4M 600K)
The recovery percentage of shareholders is computed as follows:
800,000
Assets less Liabilities at book value
360,000
Gains on realization of assets
(640,000)
Losses on realization of assets
Additional assets discovered and realized during
100,000
liquidation
Additional liabilities recorded and settled during
(60,000)
liquidation
560,000
Net assets available to shareholders
800,000
Divide by: Book value of shareholders' equity
Recovery percentage of shareholders
0.70
6. Solution:
Requirement (a):
Answer: 400,000 (2M x 20% recovery of inside creditors)
Requirement (b):
Answer: None Before anything can be paid to owners, all of the
claims of creditors, outside and inside, must be paid first. Since inside
creditors are not paid in full, none will be paid to owners.
7. Solution:
The net free assets are computed as follows:
Amount realized from sale of assets
Amount paid out of the proceeds (1.080M + 740K)
Realizable value of remaining assets
(640K+280K+1.030M)

Total assets at realizable values

Less: Unsecured creditors with priority (520K + 80K
estimated liquidation expenses)

Fully secured creditors (limited to realizable value of

collateral) - (error) a
Realizable value of asset pledged to partially secured
creditors
Net free assets

1,880,000
(1,820,000)
1,950,000
2,010,000
(600,000)
(640,000)
(280,000)
490,000

The total unsecured liabilities without priority are computed as follows:

980,000
Unsecured creditors without priority (880K+100K)
80,000
Deficiency of assets pledged to "fully" secured creditors
240

(error) a
Deficiency of assets pledged to to partially secured
creditors [(1.040M-740K)-280K]
Total unsecured liabilities without priority

20,000
1,080,000

The assets described in the accountants working papers as

pledged to fully secured creditors are actually pledged to
partially secured creditors (also, the fully secured creditors are
actually partially secured) as shown in the computations below:
Unpaid balance of fully secured liabilities (1.8M 1.080M)
Assets pledged to fully secured creditors
Deficiency to "fully" secured creditors
Estimated recovery percentage
of unsecured creditors without
priority

720,000
640,000
80,000

Net free assets

Total unsecured liabilities
without priority

= (490,000 1,080,000) = 45.37%

8. Solutions:
Requirement (a):
Date
Various assets (at book value)
Estate deficit (squeeze)
Various liabilities (at book value)

600,000
40,000
640,000

Requirement (b): Estimated deficiency to unsecured creditors

The estimated deficiency to unsecured creditors without priority in the
statement of affairs is computed as follows:
Total assets at realizable value (500K + 10K dividend
510,000
receivable)
Total liabilities at realizable value (640K + 4K interest payable
(664,000)
+ 20K estimated administrative expenses)
Estimated deficiency to unsecured creditors without
priority
(154,000)
9. Solutions:
Requirement (a): Net gain (loss)
Debits

Credits

Assets to be realized
Assets acquired

4,000,000
30,000

2,360,000
440,000

Liabilities liquidated

4,260,000

5,740,000

Liabilities not liquidated

2,380,000

64,000

241

Assets realized
Assets not realized
Liabilities to be
liquidated
Liabilities assumed

Supplementary expenses
Totals

50,000

36,000

10,720,000

8,640,000
2,080,000

Supplementary
income
Totals
Net Loss excess
of debits over
credits

Requirement (b): Ending balance of cash

ASSETS
200,000

LIABILITIES AND EQUITY

Liabilities not
liquidated
2,380,000

Cash
Assets not
realized

440,000

Estate deficit

TOTALS

640,000

TOTALS

(Squeeze)

242

(1,740,000)
640,000

(Start)